Analyzing the External Environment of the Firm


The purpose of this chapter is to familiarize students with techniques for evaluating a firm's external environment. This chapter focuses on the value managers add when they have a sense of events outside the company. By focusing on external events, managers are able to stay a step ahead of competitors by accurately anticipating and promptly responding to actions that can impact the organization. The chapter is organized into three sections.


1.   The environmentally aware organization. Emphasize that managers use scanning, monitoring, and competitive intelligence to develop forecasts. Also, the role of scenario planning is discussed.


2.   The influence of the six broad segments (demographic, sociocultural, political/legal, technological, macroeconomic, global) of the general environment of the firm.


3.   The role of the competitive (also called the task or industry) environment and its analysis through the application of Porter's five forces model. We also address the concept of strategic groups. Managers use strategic groups to identify who its main competitors are and how a company fits in with the overall industry in which it competes. 





       The introductory case is Interstate Bakeries Corporation's failure to respond to trends in the baking industry. Use the example to illustrate how a firm's failure to recognize trends in consumer preference, the industry, and among competitors can cause business failures. Explain that scanning, monitoring, and competitive intelligence are all separate, discrete techniques that lead to business forecasts.


q                    What are the key points in the case?


q                    What other organizations have misread their external environment? What were the consequences?




We address three important processes—scanning, monitoring, and gathering competitive intelligence—which managers use to develop forecasts. EXHIBIT 2.1 depicts relationships among these activities. Also, we address scenario planning and its role in anticipating future major changes in the external environment as well as the role of SWOT analysis.


The SUPPLEMENT below provides an historical perspective of the need for environmental awareness from the computer industry. This is, of course, an industry with which the students should be more familiar.  (The authors are consultants with McKinsey & Company in Palo Alto, California.)


Environmental Awareness and the Computer Industry


In the late 1970s, huge, vertically integrated companies like Burroughs, IBM, and Digital Equipment dominated the computer industry. With their vast scale advantages and huge installed bases, they seemed unassailable. Yet just ten years later, the power in the industry had shifted. The behemoth firms were struggling to survive while armies of smaller, highly specialized companies were thriving.  What happened?


The industry's sea change can be traced back to 1978 when a then tiny company, Apple Computer, launched the Apple II personal computer. The Apple II's architecture unlocked the computer business, allowing the entry of new companies that specialized in producing specific hardware and software components.  Immediately, the advantages of the generalist—size, reputation, vertical integration—began to whither. The new advantages—creativity, speed, and flexibility—belonged to the specialist… As a result, tightly coordinated webs of specialized companies—with names like Apple, Intel, Microsoft, Sun Microsystems, and Adobe—could form and ultimately compete against the entrenched, vertically integrated giants…


The Lesson:  Executives will be forced to ask the most basic question about their companies: What business are we really in?


Source:  Hagel, J. III & Singer, M. 1999. Unbundling the corporation. Harvard Business Review, 77(2): 133-139. 




Environmental scanning involves surveillance of the firm's external environment to predict environmental changes to come and detect changes that are already underway. We discuss the examples of (1) BP Amoco and (2) three of the eight "key issues" (globalization; time to market; and shifting roles and responsibilities) facing the automobile industry according to A. T. Kearney.


q          Why would an automobile executive be at a disadvantage if s/he were not aware of such trends?




Environmental monitoring tracks the evolution of trends, events, or streams of activities

in the external environment. In this section, we present some of the factors monitored by three organizations: Motel 6, Pier 1 Imports, and Johnson and Johnson Medical Products. Such factors are vital for managers in determining their firm's strategic direction and resource allocations.


The SUPPLEMENT below represents the factors that the Director of Planning of Vought Aircraft considered critical. You may initially ask the students:


q          What indicators do you believe a firm should monitor that produces both (1) weapon systems for the military, and, (2) key components for the commercial aircraft industry?


Factors to Monitor—Vought Aircraft


Commercial Aircraft:

1.         Oil prices

2.         Age of fleet of airlines

3.         Profitability of airlines


Defense Department:

1.         Where weapons are in the life cycle

2.         Mission requirements of the military


Source:  Authors' interviews.




Competitive intelligence helps firms define and understand their industry and identify rivals' strengths and weaknesses. Done properly, competitive intelligence helps a company to avoid surprises by effectively anticipating and responding to competitors' moves.


We briefly address the importance of competitive intelligence to firms in the banking, airline, and automobile industry.


q          What are other industries where competitive intelligence is extremely important? How might such information be collected?


We address how the Internet has accelerated the speed at which firms can find competitive intelligence.


The following SUPPLEMENT provides an interesting perspective by Tracey Scott, past president of the Society of Competitive Intelligence Professionals:


The "People Side" of Competitive Intelligence


"I distinguish between secondary information—stuff that you read on the Web or in reports—and human-source information: stuff that real people tell you.  Human-source information is more interesting and more accurate than secondary information. That's why I always look for 'star talent' and think about what the comings and goings of those people mean. I also love conference proceedings.  Most companies send their best people to speak at conferences.  It's a great way to track talent and to track down people who might have useful information and insights."


Source:  Imperato, G. 1998.  Competitive intelligence:  Get smart. Fast Company. April-May: 270.


q          Do you agree with Ms. Scott's perspective? Do you feel she overstates her case? Why? Why not?


EXHIBIT 2.2 further clarifies what competitive intelligence (CI) is all about. It provides four contrasting issues on what CI "is" and "is not."


STRATEGY SPOTLIGHT 2.1 discusses some of the ethical guidelines that United Technologies has implemented.


q                    Are you aware of ethical guidelines that other companies have developed? Were they effective? Why? Why not?


Teaching Tip:  The discussion of Competitor Intelligence provides the instructor with an opportunity to introduce the subject of ethics into the classroom. We suggest presenting scenarios that are not "black and white." For example, a firm advertises a position in order to get a chance to interview employees of a rival company with no intention to hire them. While this may not be illegal, clearly it is difficult to justify morally. The ensuing discussion will help to clarify the distinction between illegal and unethical behavior.




Environmental scanning, monitoring, and competitive intelligence are important inputs for analyzing the external environment. However, they are of little use unless they provide raw material that is accurate enough to help managers make accurate forecasts. 


We address the twin problems of either assuming that the world is certain and open to precise predictions, or the assumption that it is uncertain and totally unpredictable. And, we provide the famous example of poor forecasting of the British/French supersonic transport, the Concorde.


q          What are some other errors in forecasting with which you are familiar?


The SUPPLEMENT below provides an example of how a retail firm, Japan-based World Company and Spain-based Zara estimate future demand for their products:


Forecasting in the retail industry


Early product sales, appropriately adjusted for variations in price and availability, are an excellent predictor of overall sales. In fact, retailers that exploit these data for production and inventory planning can more than double their profits—especially retailers of products with short life cycles, such as clothing, consumer electronics, books, and music.


Several companies have retailing practices worth emulating. Japan-based World Company and Spain-based Zara are fashion retailers whose merchants systematically examine early sales data to estimate future demand for their products. They conduct this analysis for every product at pre-determined periods in its sales cycle. And the merchants follow through, immediately reordering items that look as though they might end up in short supply. Not surprisingly, World Company has attained a gross-margin return on inventory investments of more than 300 percent—a substantially higher return than any other retailer that we are aware of.


Source:  Fisher, M. L., Raman, A., & McClelland, S. 2000. Rocket science retailing is almost here—Are you ready? Harvard Business Review, 78 (4): 116.


Scenario planning provides a set of tools that enable managers to imagine threats and opportunities the future may bring. As a general rule, scenarios should be used by businesses whose external environments are prone to fundamental or sudden change and whose anticipation of such change is of vital strategic importance.


It is important to note that scenario planning draws on a wide range of disciplines and interests, among them economics, psychology, sociology, and demographics.


q          Why must scenario planning draw on a variety of disciplines and interests?


We provide the example of Lego, and how its position in the toy industry may become eroded if they define their industry—and its future—in a very narrow context.


STRATEGY SPOTLIGHT 2.2 includes the example of Shell Oil Company has benefited from the use of scenario analysis.


F.    SWOT Analysis


We briefly address SWOT Analysis at this point. SWOT stands for strengths, weaknesses, opportunities, and threats. SWOT analysis provides a framework for analyzing these four elements of a company's internal and external environment.


It is important to note that SWOT analysis provides the "raw material", that is, a basic listing of conditions and factors inside and outside of a company.


q          What do you consider to be some of the major advantages and disadvantages of SWOT analysis?  (This issue is addressed in more detail in Chapter 3, but you should point out that a key disadvantage is that strengths may not necessarily convert to sources of competitive advantage that are sustainable in the marketplace.)




The general environment consists of factors that can have a dramatic effect on a firm's strategy.  Typically, a firm has little ability to predict trends and events in the general environment, and even less ability to control them.


We divide the general environment into six segments: demographic, sociocultural, political/legal, technological, economic, and global.


EXHIBIT 2.3 provides examples of key trends and events in each of the six segments of the general environment


q          How will the factors in Exhibit 2.3 affect specific industries?


q          Which factors are more difficult to predict than others?  (e.g., macroeconomic changes are typically more difficult to predict than demographic changes)


q          How are these factors interrelated?


q          What factors do you feel are important that are not listed in this exhibit?




Demographics are the most easily understood and quantifiable elements of the general environment. Demographics include elements such as the aging population, rising or declining affluence, changes in ethnic composition, geographic distribution of the population, and income level disparities.


q          What are the implications of ethnic diversity for the work place?


q          What implications do the migration to the South and West in the United States have for individual businesses?


q          How does the "graying of America" affect U. S. companies?


Among the trends we discuss are the aging of the population and how it may differentially affect a wide variety of industries. We also discuss the increasing number of wealthy Americans as well as changes in the geographic population of the United States.


The SUPPLEMENT below, building upon STRATEGY SPOTLIGHT 2.3, addresses some interesting projections on the "aging" workforce and its implications:





         In the United States, the overall rate of the workforce growth will face a sharp drop.  After peaking at nearly 30 percent in the 1970s (as the baby boomers as well as unprecedented numbers of women entered the workforce), and holding relatively steady at 12 percent during the 1990s and the present decade, the rate is projected to level off at 2 to 3 percent per decade thereafter. This translates into an annual growth rate of less than 1 percent today and a tiny 0.2 percent by 2020. The proportion of workers over 55 declined from 18 percent in the 1970s to under 11 percent in 2000. However, it is projected to rebound by 20 percent by 2015.  Stated another way, we have recently passed what will prove to be a historic low in the concentration of older workers. Just when we have gotten accustomed to having relatively few older workers around, we have to start learning how to attract and retain far more of them.


         During the next 15 years, 80 percent of native-born workforce growth in North America—and even more so in much of Western Europe—is going to be in the over-50 cohort.  In the next decade or so, when baby boomers—the 76 million people born between 1946 and 1964, more than on-quarter of all Americans—begin their sixties and contemplate retirement, there won't be nearly enough young people entering the workforce to compensate for their exodus. The Bureau of Labor Statistics projects a shortfall of 10 million workers in the United States in 2010, and in countries where the birthrate is well below the population replacement level (particularly Western Europe), the shortage will hit sooner, be more severe, and remain chronic.


Source:  Dychtwald, K. Erickson, T. & Morison, B. 2004. It's time to retire retirement. Harvard Business Review, 82 (3): 48-57.





q                    It might be interesting to ask what the implications are for today's organization (e.g., how can firms attract and retain older workers, changes in financial and non-financial incentives, etc.) as well as for public policy (e.g., changes in tax policies, increasing the number of immigrants, etc.).



       STRATEGY SPOTLIGHT 2.3 discusses an important demographic trend – older employees in the workforce.




Sociocultural forces influence the values, beliefs, and lifestyles of a society. Examples include a higher percentage of women in the workforce, dual-income families, increases in the number of temporary workers, greater concern for healthy diets and physical fitness, greater interest in the environment, and families postponing having children.


q                    Name two industries that have benefited from the growing awareness about health and fitness. Also name two that have been adversely affected by this trend.


q                    What must firms do to attract and retain women employees? Why are such efforts becoming increasingly important?


The section also addresses the increased educational attainment of women in the workplace.  We discuss increases in both the number of degrees granted to women as well as the increased formation of businesses by women.


       STRATEGY SPOTLIGHT 2.4 discusses the significant role that women play in the making of important consumer decisions.




q          Can you think of any other important implications this trend has for businesses in a specific industry?





Political processes and legislation influence the regulations with which industries must comply.  Some important elements of the political/legal arena include tort reform, the Americans with Disabilities Act (ADA), the repeal of the Glass-Stegall Act in 1999 (now banks may offer brokerage services), deregulation of utilities and other industries, and increases in the federally mandated minimum wage.


q          What do you see as some of the pros/cons of the Americans with Disabilities (ADA) Act?


q          Do you think the federally mandated minimum wage should be increased? What are the implications?


q          Should there be tort reform—such as setting limits on the amounts that juries can award in personal injury cases?



       Another area where visa restrictions is having an important impact is "very close to home" — universities. In the SUPPLEMENT below we provide an example of one student who elected to attend an M.B.A. program in China (because of visa concerns in the United States) and the fact that applications from Asian students have declined by as much as 50 percent at some U.S. business schools.




         Paul Foo was a very attractive M.B.A. applicant — he could have had his pick among America's most prestigious M.B.A. programs. A graduate of Cambridge University in England, he had worked for three years at an investment bank in his native Malaysia before applying to business school. The University of California at Berkeley offered him a half-tuition scholarship and Thunderbird in Arizona (American Graduate School of International Business) offered him a full scholarship. Although he felt the offers were tempting, he was concerned about immigration headaches.


         Foo had heard horror stories about Asian M.B.A. students waiting up to six months for a visa to reenter the U. S. after summer break. He had also heard about difficulties finding jobs in the United States after graduation. Thus, Foo decided to attend the China Europe International Business School in Shanghai. (He even gave up a Fulbright Scholarship that was contingent upon his attending a university in the United States.)


         Asian students are increasingly ignoring U. S. business schools, troubled by tougher U. S. immigration laws and enticed by China's rapid economic growth. Applications from Asian students are down by as much as 50 percent at U. S. business schools. This decrease is troubling since Asian students typically pay full tuition, says Richard E. Sorensen, chairman of the Association to Advance Collegiate Schools of Business.


Source:  Ridgway, N. 2005. Brain drain. Forbes. September 5: 154.



In this section we address some of the implications of tort reform. We also discuss some of the implications of legislation that may expand the number of temporary visas available for highly skilled foreign professionals. (It may be interesting to pose questions on this issue given the September 11, 2001 terrorist attacks, i.e., whether or not the number of visas should be restricted in some manner.)




Developments in technology lead to new products and services and improve how they're produced and delivered to the end user. Innovations can create entirely new industries and alter existing industries.


q          Ask students to speculate on the impact of the following technologies on American industry:  (1) the Internet, (2) manufacturing innovations (e.g., robotics), (3) genetic engineering/designer genes.  (The last items may provoke some heated discussion regarding the ethical implications.)


We discuss the key implications that the Internet has had on industry — in particular, its impact on productivity gains.


EXHIBIT 2.4 addresses a fascinating issue: some of the promising future applications of nanotechnology and how it will impact some industries.


       The SUPPLEMENT below discusses how technology developed by NASA is making important contributions outside of the space program.




During the summer of 2003, wildfires raged in a dozen states. Firefighters are turning to technology to curb the recent, unusually heavy forest-fire damage: 7 million acres over a recent 12-month period.  This is nearly double the annual average in the 1990s.


NASA has developed tools to help the U. S. Forest Service to find and fight the blazes.  Four times a day, NASA satellite images are passed to the Forest Service's fire management center in Salt Lake City.  And soon, researchers at Rochester Institute of Technology could develop a remote-sensing system that could spot a foot-wide fire from an aircraft flying at 10,000 feet. NASA is also working to install the gear in unmanned aerial vehicles such as the robot spy planes that flew in Afghanistan and Iraq.


Source:  Port, O. 2003. Fighting forest fires with space-age tools. BusinessWeek, August 11: 53.


We close out the section by addressing some of the "downsides" of technology. In addition to ethical issues, we discuss environmental damage, such as the emission of greenhouse gases. We discuss BP Amoco's innovative approach to this matter.




The economy has an impact on all industries, from suppliers of raw materials to manufacturers of finished goods and services, as well as all organizations in the service, wholesale, retail, government, and nonprofit sectors of economies. Key indicators include interest rates, unemployment rates, the consumer price index (CPI), the Gross Domestic Product (GDP), and net disposable income.


q          Compare the impact of rising (or declining) interest rates on the overall demand for the following industries: (1) housing (will have a significant impact), (2) automobiles (will have a significant impact), (3) fast food (will have very little effect).





Globalization provides both opportunities to access larger potential markets and a broad base of factors of production such as raw materials, labor, skilled managers, and technical professionals.  However, such endeavors carry many political, social, and economic risks. Examples of important elements in the global segment include currency exchange rates, increasing global trade, the economic emergence of India, China's admittance to the World Trade Organization, trade agreements among regional blocs (e.g., EC), and the GATT Agreement (lowering of tariffs).


q          Provide examples of firms that have succeeded (stumbled) in their efforts to expand into international markets. What factors can explain their success (failure)?


We discuss the globalization of the automobile industry — in particular, the attraction of developing markets. We provide the example of the Norwegian shipping industry to illustrate its global nature.


The SUPPLEMENT below addresses some of the issues pertaining to the global impact of the September 11, 2001 terrorist attacks in the United States and the "War on Terror."  (You may consider posing a question on this issue prior to discussing the supplement)


The Global Implications of September 11, 2001


As companies worry more about the safety of their staff and facilities, the free flow of people and goods could slow, hurting economic efficiency. Because the higher cost of capital, investment won't return to boom-era levels. That, in turn, could mean that even when the United States emerges from recession, it will be hard-pressed to return to the 4 percent baseline growth it achieved during the go-go years of the 1990s. In short, America's golden age of prosperity—and the promise it held for global growth—may have hit its zenith.


Globalization certainly isn't going to disappear—the world's markets are too vitally integrated to roll back now.  But globalization could well become slower and costlier, crimping the high-productivity, low-inflation model of the 1990s. Companies will likely have to pay more to insure and provide security for overseas staff and property.  Heightened border inspections could slow movements of cargo, forcing companies to stock more inventory. And, tighter immigration policies could curtail the liberal inflows of skilled and blue-collar laborers who allow companies to expand while keeping wages in check.


Source:  Engardio, P. 2001. What's at stake? Business Week. October 22: 35.




In our discussion of the general environment, we have addressed many relationships among the various elements. 


EXHIBIT 2.5 provides many examples of how the impact of trends or events in the general environment can vary across industries.




Here, we draw upon a well-known analytic tool, Michael Porter's five forces model of industry competition. We introduce this model and discuss examples of each force. We then address the strategic groups concept and its implications for studying rivalry and competition. 




EXHIBIT 2.6 illustrates Porter's five forces model of industry competition


When introducing this model, it is useful to show how the model provides insight into an industry's dynamics and expected profit levels. The SUPPLEMENT below provides such an analysis on the paint and allied products industry. The analysis is restricted to the trade sales (i.e., house paint) segment of the industry. The competitive forces are very different for other segments such as the specialized high-tech automobile finishes.


Note:  For our purposes of illustrating the "basics" of the "five forces," the analysis has been simplified. We assume buyers to be consumers, although there are, of course, other distinct groups such as hardware stores, and large discounters such as Wal-Mart. Obviously firms' bargaining power vis-à-vis paint manufacturers vary significantly. Similarly, our analysis assumes the industry's products to be commodity products. However, there are exceptions, such as Olympic Stain, that have successfully differentiated their products on the basis of quality.


The Paint and Allied Products (PAP) Industry


An analysis of the Paints and Allied Products industry (SIC 2851), using the five forces model, demonstrates why this industry has traditionally been caught in a price-cost squeeze and is unable to pass on rising raw material costs to its customers.


To illustrate the price-cost squeeze that this industry is facing, consider that between the years 1995 to 2000, the PPI (producer price index — the price for which it sells its output) of the PAP industry increased an average of only 2 percent. The PPI for petroleum refining and related products — a key supplier to this industry — increased at a rate of 6 percent over this same period of time. Hence the price of this key raw material was roughly twice the rate of inflation (about 3 percent); whereas, the PAP industry was lower than the rate of inflation.  Thus, the PAP industry has been unable—due to unfavorable industry competitive forces — to pass on cost increases to their suppliers; thus eroding profitability.


Consider the PAP industry in terms of each of Porter's Five Forces:


Threats of Entry: Very High (minimal capital investment needed, little proprietary technology, regional firms can compete in local markets due to high transportation costs, little brand identification of existing competitors)


Buyer Power: Very High (low brand loyalty, relatively little product differentiation, relatively low switching costs)


Supplier Power: High (especially for petroleum derivative raw materials—a key input in industry)


Substitute Products: High (plastics, wood paneling, wallpaper coverings, etc.)


Rivalry: High (competition is based mostly on price competition, because of little brand loyalty and product differentiation; easy entry and exit from the industry gives rise to frequent price wars; little price leadership exhibited by larger firms)


Sources:  www.bls.gov (Bureau of Labor Statistics); www.ita.doc.gov (International Trade Administration)



       It is useful to point out that there can also be very profitable opportunities to compete in industries that have overall low profits, overall. For example, in the paint industry, Olympic Stain has typically been a very successful and highly-profitable firm because they have found an attractive niche in the market and developed a differentiated product (through product development and advertising). The SUPPLEMENT below provides two examples of how attractive opportunities were exploited in what seemed to be unattractive market segments.













         Paychex, a payroll-processing service company built nearly a billion-dollar business by serving small businesses. Existing firms had ignored these customers because they assumed that such firms could not afford the service. When Paychex's founder, Tom Golisano, failed to convince his bosses at Electronic Accounting Systems that they were missing a great opportunity, he launched a firm that now serves 390,000 U. S. customers — each employing about 14 employees. Paychex's after-tax-return on sales is a stunning 29 percent — equal to Mircosoft's and greater than the margins of the pharmaceutical money machines Amgen and Pfizer.


         Also, consider WellPoint Health Network, which suffered $160 million in losses in 1986 (when it was known as Blue Cross of California). At that time, Leonard Schaeffer became CEO and challenged the conventional wisdom that individuals and small firms were money losers.  (Clearly, this was a counterintuitive move since the firm was losing $45 million a year insuring 65,000 individuals!) However, by the early 1990s, the health insurer was leading its industry in profitability, and the firm has continued to grow and outperform the rest of its sector even during economic downturns.


Source:  Rosenblum, D., Tomlinson, D., & Scott, L. 2003. Bottom-feeding for blockbuster businesses. Harvard Business Review, 81 (3): 52-59.





After summarizing the major barriers to entry, ask students to provide examples of industries characterized by each of these entry barriers. This may help them to understand what initially may appear to be rather complex ideas. 


We discuss the example of ProCD — a firm (producing electronic telephone books) that failed because of low entry barriers.


Teaching Tip: The chapter explains how economies of scale and economies of experience (learning curve) erect significant entry barriers. In the auto industry, U.S. manufacturers such as Ford and G.M. have high economies of scale (being the biggest producers) and all the benefits of learning curve (having been in the business for almost a century). Despite these advantages, foreign auto producers have entered the U.S. market and have increasingly gained market share over the past few decades. Ask the students why this happened? Does this prove that the concepts we discussed are wrong? Or does it point out that additional factors have to be considered? Point out that foreign producers have the benefits of lower labor costs and/or have developed better manufacturing technologies (such as Toyota's lean manufacturing).




Briefly summarize some of the conditions under which a supplier group may become powerful.  It may be interesting how things have changed (if they have) with regard to the power of buyers of talent (i.e., businesses of varying sizes and industries) and suppliers of talent (i.e., business school graduates—either undergraduate or MBA).





Briefly discuss some of the conditions under which a supplier group may become powerful. The bargaining power of suppliers can be presented as the mirror opposite of the bargaining power of suppliers. For example, the relative sizes and concentrations largely determine the bargaining power of the two parties involved in the transaction.


The section discusses the relative power of the providers of talent — ranging from unskilled labor (low) to highly skilled professionals (high). Especially hard hit will be several unions such as those in declining industries such as steel manufacturing.


STRATEGY SPOTLIGHT 2.7 discusses how a group of catfish farmers formed a cooperative, Delta Pride Catfish, to process their own catfish – an example of forward integration by suppliers.




Emphasize that the viability of a substitute product depends largely on its relative price-performance trade-off, i.e., more value for the same price or the same value for a lower price. Examples are electronic security systems versus security guards, and the use of steel versus plastic for components in the manufacture of automobiles.


We discuss substitutes and give the example of IBM's use of teleconferencing. Clearly, this technology poses a threat to the airline industry.


The SUPPLEMENT below addresses important substitute products/services that threaten to erode the surplus of the United States Postal Service (USPS). These substitutes are e-mail and online bill paying.


Tough Competitors to the USPS


After operating at a surplus — helped by a booming economy — the quasi-governmental mail agency has plunged as much as $3 billion into the red, its greatest deficit in modern history.


The USPS warned long ago that email and online bill paying threatened its core business. And indeed, a recent slowdown in first-class mail has hit hard, while cheap advertising mail has filled letter carriers' bags.  That combination hurts two ways: Revenues fall short of projections while costly deliveries are up. Way up: The USPS must deliver its ever less profitable mix of mail to 2 million added addresses every year.  Its workforce has grown with its workload, to more than 900,000 — the second largest U. S. civilian force after Wal-Mart's. Labor costs eat up 76 percent of its revenues, compared to only 56 percent at United Parcel Service and 42 percent at FedEx Corporation.


Source:  Lavelle, M. 2001. Why the postman can't deliver profits. U.S. News & World Report. April 9: 46.




After discussing the factors that lead to intense rivalry in an industry, provide an example of an industry in which competition has recently been intense. For example, most students are familiar with the recurring price wars in the U. S. airline industry. Ask them to explain this using the factors discussed (e.g., undifferentiated service, low switching costs, slow industry growth, numerous competitors, etc.)  You might point out that this industry was expected to report huge losses in 2001 even before the September 11, 2001 terrorist attack. Beginning in late 2005, the airlines' problems were further aggravated by extremely high fuel costs.


       In this section we discuss the intense rivalry between Pfizer's Viagra (impotence treatment product) and a competing product developed by Eli Lilly & Company and Icos—Cialis. This provides an example that intense rivalry can take place on factors other than pricing in an industry that is highly profitable.


The SUPPLEMENT below is Michael Porter's response to a question as to whether or not he would add a "sixth force" if he were developing his framework today.





         "There have been two nominees for the sixth force. One is government. After much further work using and teaching the framework, I have reaffirmed my original conclusion that government is not a sixth force because there is no monotonic (direct linear) relationship between the strength and influence of government and profitability of an industry. You can't say that "government is low, industry profitability is high." It all depends on exactly what government does. Also, there are many different parts of government, each with its own distinct impacts. And, how do you assess the consequence of what government does? Well, you look at how it affects the five forces.


         "The other, more recent, candidate for a sixth force involves organizations whose products and services are complementary to the primary organization's products and services.  Again, there is no monotonic relationship between the extent of complements and profitability.  Sometimes having many complements is consistent with high industry profitability, sometimes with low profitability. It has to do with how complements affect the five forces…Clearly, complements have much to do with the size of the pie, but their role in the division of the pie is independent on other factors."


Source:  Argyres, N. & McGahan, A. M. 2002. An interview with Michael Porter. Academy of Management Executive. 16 (2): 43-52.






       This section was written as a "caveat" to address some limitations of Porters five forces model. First is the idea that business is not always a "zero-sum game"— which is an assumption that is implicit in Porter's five forces model. We discuss how companies can collaborate with each other for mutually beneficial outcomes.


       The SUPPLEMENT below provides a more detailed example of "win-win" relationships in the supermarket industry.





The benefits of close supplier-buyer relationships


Experts in the supermarket industry believe that seamless partnerships between manufacturers and supermarkets would accelerate the deployment of sophisticated systems such as just-in-time delivery, electronic data interchange, and so-called efficient-consumer-response systems that permit manufacturers to monitor sales in stores and to produce and ship their goods in response to actual customer demand.  Such cooperative systems could squeeze $30 billion in excess costs out of the industry by eliminating superfluous inventory, duplicate functions, and various middlemen. Moreover, the results witnessed when manufacturers and supermarket chains do cooperate suggest that both sides could increase sales volume by working together to customize offerings at different stores and for different end users.  Cooperation between Kraft Foods and supermarket chains such as Publix Super Markets in Florida and Wegman's Food Markets in upstate New York has generated significant returns for both sides.


Source:  Kumar, N. 1996. The power of trust in manufacturer-retailer relationships. Harvard Business Review, 74(6): 95.


The second issue we raise is that the five forces analysis has often been criticized for being a static — rather than a dynamic analysis. Brandenberger and Nalebuff introduced the concept of the value net which we include in Exhibit 2.7.


Transparency XX (Ex. 2.7) The Value Net


       The concept of complementors is often considered to be the single most important contribution of value net analysis. Complements typically are products or services that have a potential impact on the value of the firms' own product and services. We provide the examples of complements (software and microprocessors) in the personal computer industry and the video game industry. (As we noted in an earlier supplement, Professor Michael Porter would not add complements to the "five forces" because they don't have a direct linear relationship to industry profitability. However, they clearly can have an impact on an industry's profitability.)




       In this section, we draw on Professor Anita McGahan's work on the analysis of industry evolution. Her analysis is based on the identification of the core activities and core assets of an industry and the threats that they face. Her framework provides a two-by-two typology to form four possible types of evolutionary trajectories — radical change, creative change, intermediating change, and progressive change. It is shown in Exhibit 2.8.


Transparency XX (Ex. 2.8)  Four Evolutionary Trajectories…


       In addition to the implications discussed in the text, it may be helpful to address some of the implications for diversification. These are included in the SUPPLEMENT below:










         In the paragraph below, Professor McGahan addresses some of the implications that her approach has for diversification:


         Some of the most exciting opportunities associated with industry evolution relate to diversification across industries. By participating in more than one industry on a progressive trajectory, Wal-Mart has enhanced the effects of its powerful distribution systems. And with its acquisition of Kinko's, FedEx has diversified in response to radical change. Some of the major challenges of diversification have to do with sharing core activities and core assets across divisions on different trajectories, and developing clear lines of authority for resolving disputes between divisions as their industries create different investment requirements. It is virtually impossible to diversify profitably without understanding the differences in the trajectories and phases of industry change.


Source:  McGahan, A. M. 2004. How industries change. Harvard Business Review. 82 (10): 94.


Teaching Tip: Even when industry analysis shows that an industry is unattractive, there are a few firms that seem to be able to earn high returns. For example, Southwest Airlines has been consistently profitable in an otherwise unattractive industry over the past several years. Does this mean that industry analysis is misleading? You may point out that industry analysis is useful to predict an industry's average profitability, but not necessarily, a single firm's profitability. This is a good opportunity to introduce the role of the strategist in outperforming industry norms.




Most of your students are probably very interested in the automobile industry.  EXHIBIT 2.9 provides a strategic grouping of the worldwide automobile industry. It is rather clear from the discussion in the text that the intensity of competition within strategic groups is much more intense than competition across groups.


       Point out four benefits of strategic groups as an analytical tool:


1.         Strategic groupings help a firm identify mobility barriers that protect a group from attacks by other groups.


2.      It helps a firm to identify groups whose competitive position may be marginal or tenuous.


3.      It helps chart the future directions of firms' strategies.


4.         It helps in thinking through the implications of each industry trend for the strategic group as a whole.


It may be interesting to ask the students what dynamics they envision in the automobile industry, i.e., how membership in strategic groups may change and if new strategic groups may emerge.


q          What are some of the strategic groups in other industries with which you may be familiar? What are the implications?  (e.g., retailing)





Managers must analyze the external environment to minimize or eliminate threats and exploit opportunities. This involves a continuous process of environmental scanning and monitoring as well as obtaining competitive intelligence on present and potential rivals. These activities provide valuable inputs for developing forecasts. In addition, many firms use scenario planning to anticipate and respond to volatile and disruptive environmental changes.


We identified two types of environment: the general environment and the competitive environment. The six segments of the general environment are demographic, sociocultural, political/legal, technological, economic, and global. Trends and events occurring in these segments, such as the aging of the population, higher percentages of women in the workplace, governmental legislation, and increasing (or decreasing) interest rates, can have a dramatic effect on your firm. A given trend may have a positive impact on some industries and a negative or neutral impact, or none at all on others.


The competitive environment consists of industry-related factors and has a more direct impact than the general environment. Porter's five forces model of industry analysis includes the threat of new entrants, buyer power, supplier power, threat of substitutes, and rivalry among competitors. The intensity of these factors determines, in large part, the average expected level of profitability in an industry. A sound awareness of such factors, both individually and in combination, is beneficial not only for deciding what industries to enter but also for assessing how a firm can improve its competitive position. We also addressed some of the limitations of Porter's five forces model, including its "zero-sum perspective" and its omission of the key role of complements. Although we discussed the general environment and competitive environment in separate sections, they are quite interdependent. A given environmental trend or event, such as changes in the ethnic composition of a population or a technological innovation, typically has a much greater impact on some industries than on others.


The concept of strategic groups is also very important to the external environment of a firm.  No two organizations are completely different nor are they exactly the same. The question is how to group firms in an industry on the basis of similarities in their resources and strategies. The strategic groups concept is valuable for determining mobility barriers across groups, identifying groups with marginal competitive positions, charting the future directions of firm strategies, and assessing the implications of industry trends for the strategic group as a whole.


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